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How to Decide if You Should Loan Someone Money

December 10, 2015 at 12:00 AM

One of the trickiest money issues you will ever have to navigate is when someone you love comes and asks you for a loan. Or if you see someone you love is having a tough time financially and you want to loan them money to help.

What I too often see is that incredibly caring and thoughtful people are blinded by their desire to help, and don’t carefully consider the ramifications of making a loan: for themselves and the recipient. That can just lead to heartache and bigger financial problems.

Before you offer a loan to anyone, make sure you can pass my 3-step Loan Test.

  1. Will a loan really help this person? Do they need a loan because of some unforeseeable problem—a health issue, a layoffor because they have made bad decisions with money and have a big hole to dig out of? If it’s the latter, I don’t think loaning that person money is necessarily going to help. Oh sure, your money might help them pay off some pressing bill, but if they don’t respect money, you and I both know they will likely just fall into more money trouble. Before you ever loan money to someone who has made bad decisions in the past, you need to be assured that they have begun to take the steps to becoming responsible with money. 
  2. Can you honestly afford to help? You are to never ever reduce your emergency savings to the point that it puts your own financial security at risk. You know that I think it is smart to always have eight months of living expenses set aside in an emergency fund. Any loan that reduces your emergency fund below the eight-month threshold is not respectful to yourself. Please don’t do it.
  3. Are you comfortable thinking about the money as a gift, not a loan? I believe all loans should be repaid. That’s how the borrower shows their respect. But from a financial standpoint, if you honestly need the money to be repaid by a certain date, I would question whether you should make the loan.

    When you give money to someone you love, I don’t have to tell you how high the emotional stakes are. Adding a layer of financial stress is dangerous. Think about the “what if” factor. What if the loan isn’t repaid? Not only is that a financial hit, but it likely will put a tremendous strain on a relationship with someone you love. You could be out the money, and on the outs with someone very important to you.

    A good test for you is to ask yourself if you would be okayemotionally and financiallyif the loan was actually a gift that was never repaid. Be honest with yourself.

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